First Degree Price Discrimination Beckons For Airline Tickets?

The new standard, which was agreed to at a meeting of the International Air Transport Association in October, will allow airlines to ask customers searching for airfares through travel agents or Web sites to first provide their names, frequent flier numbers, contact details and other information before presenting them with prices. A few airlines are expected to test this approach this year, and it could be widely adopted in a few years, according to the trade group. A majority of the group’s 240 members, which include most American airlines though not Southwest, voted for the standard.

Industry officials say the standard, which they call “new distribution capability,” is simply a way for airlines to better tailor their services to the needs of their customers. For instance, an airline might offer a package that includes free checked baggage, an aisle seat and a 10 percent discount to frequent fliers. And customers would be able to compare competing bundles from different airlines. They also say customers will still have the option of shopping anonymously for basic fares if they choose not to provide any information about themselves.

7 comments

Isn’t there an old literature suggesting that first degree price discrimination is not always profit improving for oligopolists? Oligopolists will perfectly price discriminate over the residual demand curve, but that curve might be really elastic if we are selling products like airline tickets that are close substitutes. Vives has a paper that shows this with a simple example. Take two Hotelling firms at either end of a line. Paramaterize using a variable which affects the way distance from the consumer enters consumer utility (roughly, a measure of substitutability). With uniform prices, the Nash eqm. is that we split the market and price as monopolists on our “side”. With perfect discrimination, though, I can price compete with *all* of your customers…and I do! Indeed, for the customer lying right next to you, I can price at marginal cost, and you will be able to earn the location rent and nothing more from him. This increased competition lowers profits.

In the airplane industry, consider first degree price discrimination with American and Spirit. Spirit sells tickets cheaply, but is terrible. American would still profit from getting the Spirit consumers to fly on its planes at the Spirit price, but doesn’t do so because of the (at least in theory) uniform price constraint. If American could price discriminate, it would attempt in equilibrium to poach those consumers, which would cause Spirit’s price to fall in equilibrium.

I haven’t read one personally, though price discrimination + loyalty must be out there. If there is any simple economics about loyalty that often goes misunderstood by companies, though, it surely is that loyalty programs must be about changing choices on the margin. A handful of airlines, for instance, now tie frequent flyer miles to revenue spend, as if the miles are some sort of reward. But surely I care only about changing marginal behavior – get the guy to buy one extra ticket this year, or take one extra trip with my airline – and there is no a priori link between the behavior on the margin and the revenue generated.

The goal for airlines is to reduce the competitive pressure on the anonymous posted-price fares so that the airlines can extract more consumer surplus on the customers that have a high reservation price. The impact of this new distribution scheme will dwarf the anticompetitive effect of the recent mergers. The anonymous posted-price fare will become a meaningless “MSRP” price that very few pay except those few with very high reservation price. To get a reasonable fare, you will have to put in you demographic information, at which point, your personal price offer will be just the amount that the carrier thinks you would be willing to pay.

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